Deloitte China Research and Insight Centre March 2012, Boao Forum for Asia Annual Conference 2012 Measuring Value® China and Asia - The Forum and the Formula As the Boao Forum for Asia Annual Conference (BFA AC) enters its second decade, the discussion and potential of Asia as an integrated economic region also are entering a new stage. While intra-Asian trade has grown at an accelerating rate since the global financial crisis and several aspects of integration have proceeded smoothly, the more developed trading blocs in the world, notably North America and the European Union, have confronted many challenges in sustaining growth and balance among their member nations. As a result, at the BFA AC and other important international gatherings of government, business, and academic leaders, it has become a commonplace to refer to Asia as the world’s engine of recovery from the crisis and the epicenter of future growth. But the discussion of Asia’s regional integration has not really encompassed the challenges now being faced by other trading and common currency blocs. For example, the currencies that facilitate regional value chain integration in the developed regions of the world, primarily the US dollar and Euro, have linked together economies, like the US and Mexico or Germany and Greece, in complex and often politically challenging ways. The complex workings of regional integration are beyond the scope of this brief paper, but our goal is to look at the characteristics of Asian economic integration and identify characteristics and some ways in which the process differs from other parts of the world. Regulatory reform sets the stage for regional integrations, and that is inherently a multilateral diplomatic process. What plays out on that stage is largely determined by market and demand drivers, the commercial determinants of what happens across national borders within the region. Policy and regulatory enablers Zhang Yunling, Director, Institute for Asia Studies at the Chinese Academy of Social Sciences, observed a few years ago that immediately after its accession to the World Trade Organisation (WTO) in December 2001, China adopted a regional approach to trade and began negotiating and implementing bilateral FTA across the Asian region. China’s exports to the US and Europe had developed in such a way that major export categories contained very significant content from across Asia, including raw materials, manufactured components, and in some cases major sub-assemblies. China was the final assembler, the last stage of a long production line that stretched to Singapore, Malaysia, Indonesia, Thailand, Korea and even Australia. Post its WTO accession, China also immediately took the lead among emerging economies in promoting an emerging economy agenda. That agenda may have contributed to the slow progress of the WTO Doha Round. But it has created two defined and growing networks, an emerging economy trading group, best illustrated by China and Africa, and a regional trading group, best illustrated by China and the Association of Southeast Asian Nations (ASEAN). In 2009, China became Africa’s largest trader partner, and in 2010, China-Africa trade reached US$127 billion. Through the first three quarters of 2011, China-Africa trade grew at 30 percent, year-on-year. In January of 2010, a number of FTAs opening the borders of China and other Asian nations went into effect, establishing the China-ASEAN Free Trade Area (CAFTA), the largest trading bloc in the world in terms of population and third largest in terms of GDP. Table 1 Country GDP ($ Billion) Simple Average FTAs in effect FTA under negotiation/ 2010 MFN Tariffs(%) (number) 2011 proposed (number) 2011 Northeast Asia People’s Republic 5,926.61 9.6 12 12 of China Japan 5,458.83 4.4 12 9 Republic of Korea 1,014.48 12.1 8 22 Southeast Asia Philippines 199.58 6.3 7 5 Singapore 208.76 0 18 17 Thailand 318.52 9.9 11 3 Source: www.aric.adb.org, World bank, WTO China was not alone in promoting these agreements nor were FTAs limited to Asia. By the end of 2011, China had 24 such agreements either signed or under negotiation. Outside the ASEAN nations, Korea, which had the highest effective tariff rates in East Asia, had 22 under negotiation in 2011 alone. The pace at which previously protected markets were being opened to freer trade by virtue of these agreements underscores the spreading belief around Asia of the benefits of free trade. And the agreements were being used. By mid 2010, surveys of PRC large scale enterprises demonstrated that 65 percent were already taking advantage of FTAs with ASEAN neighbors. The FTAs not only supported intra-regional trade, but they added a level of efficiency that helped Asia remain very competitive exporting goods and services outside the region. Investment flows, which had historically been from ASEAN countries to China reversed in 2008, and were growing substantially by 2010, as Chinese enterprises extended their marketing initiatives and production sharing networks into South East Asian countries. Chart 1: China’s trade balance with ASEAN US$ (billion) 250 250 200 200 150 150 100 100 50 50 0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 China's export to ASEAN China's import from ASEAN Source: NBSC (1994-2010), China Customs (2011) 2 Although China has continued to maintain a sizeable export surplus, albeit now shrinking, as regional trade has developed, China has continued to import more from ASEAN neighbors than it exports to them. We will discuss the complementarities in resources and development models below, which suggest this is a sustainable trend that will stimulate the development of ASEAN partners with China in this trade. Complementing the FTAs, another key and distinct policy enabler is the push to make RMB a regional trading currency. The pace of RMB growth outside China has had a material effect on integration and appears destined to continue its growth. For the last several years at BFA AC, the international role of the RMB has been a major discussion topic. The global financial crisis triggered more interest in alternatives to the US dollar for trade settlement, and after the discussion of Special Drawing Rights to be established by the International Monetary Fund failed to gain traction, rules for the use of RMB outside of China were liberalised. The RMB abroad began to take off. In a highly integrated Asia-wide supply chain and market, the advantages of a common currency and reduced currency exchanges for trade and investment settlement are obvious. And they are significant. FOREX risk is eliminated if trade agreements are denominated in RMB, and that reduces the cost of transactions and eliminated hedging costs. The use of a common currency helps keep bilateral trade and investment flows in balance, and that contributes to stability in transactions and trade balances overall. The growth of the RMB as a trade settlement currency is impressive but not surprising. Remember it was only in the second half of 2010 that the RMB was approved for trade settlement in a wider range of geographies, clearing agreements were expanded, and an adequate network of interbank facilities was made available to support trade. It was at this time that RMB deposits in Hong Kong banks began to grow steeply, and trade settlement followed. By the end of December 2011, RMB deposits in Hong Kong stood at RMB600 billion and trade settled in RMB for 2011 is estimated at 2 trillion, or approximately 9 percent of China’s total. Deutsche Bank forecasts for 2012 RMB trade settlement will reach a remarkable RMB3.7 trillion, 15 percent of China’s total trade. Chart 2: RMB deposit in Hong Kong RMB (billion) 700 700 600 600 588.5 500 500 400 400 300 300 200 200 100 100 0 0 January July January July January July January July January July January July January July January July December 2004 2004 2005 2005 2006 2006 2007 2007 2008 2008 2009 2009 2010 2010 2011 2011 2011 Source: HKMA With the August 2011 visit to Hong Kong of vice-Premier Li Keqiang, the RMB abroad initiative was expanded to include investment activities. The premier promised further liberalisation of cross border capital transactions, in particular opening up equity markets to cross-border investment. He also stressed the potential positive impact of offshore RMB in the outbound investment activities of Chinese enterprises. Financial products and services were already proliferating. The Hong Kong Dim Sum bond market is well- known, and expanded bond and equity markets in Hong Kong and Singapore are being contemplated. Several types of capital transactions are now permitted under rapidly evolving guidelines, and these will expand cross-border investment activity between the Chinese Mainland and Hong Kong and between Hong Kong and ASEAN and Asian neighbors. Over time, as RMB growth continues, it will be an important global currency, but in the mid-term, the benefits of RMB use for trade and investment will primarily be felt in the Asian region and will be a distinct factor in regional integration. 3 Market and demand drivers Chinese leaders in previous BFA Forums have mentioned the massive size of the emerging consumer market in Asia, taken as a whole. There is no debate that with huge populations across the region, strong regional growth and improved standards of living are a win-win for all nations that participate in regional trade and investment growth. Beyond the predictable growth of Asian consumption, well- balanced complementarities in resources and development stages among nations within Asia provide the foundation for many win-win outcomes of increased cross-border trade and investment within the region.